Measurement of Elasticity of Demand

There are three methods for measuring elasticity of demand.

• Outlay method
• Point method
• Arc method

Outlay Method

Prof. Marshall developed outlay method to measure the degree of elasticity of demand.
According to this method, we examine whether the total outlay of the consumer or revenue of the
seller has changed after the price change. Total outlay of total revenue = Price X Quantity
purchased or sold. If the total outlay remains unchanged, after the change in price, the demand is
said to be unit elastic (ep = 1). When with a rise in price, if total outlay falls or with a fall in price
if total outlay rises, elasticity of demand is greater than unity (ep > 1). The price and total outlay
moves in the opposite direction.

When with a rise in price, if total outlay rises and with a fall in price if total outlay falls,
elasticity of demand is said to be less than unity (ep < 1). In this case we notice that price and
total outlay move in the same direction.

Table 1.Total outlay Method

Price Total outlay Type of demand
Increase Constant (e = 1)
Decrease Constant Unitary elastic
Increase Decreases (e >1)
Decrease Increases Relatively elastic
Increase Increases (e<1)
Decrease Decreases Relatively inelastic

ep = Percentage Change in Quantity Demanded

Percentage Change in Price
 ep = ΔQ/ Q
ΔP/ P
= (ΔQ/ Q) X (P/ΔP)
Where Q is the original quantity
ΔQ is the quantity after the price change
P is the original price
ΔP is the new price
ΔQ = (Q2 – Q1)
ΔP = (P2 – P1)
Illustration

Find the price elasticity of demand from the following data.

Price of sugar : 10 20 40 10 20 40 10 20 40
Quantity Purchased: 100 75 65 100 50 25 100 45 15
Solution

Price of Sugar Quantity Demanded Total Outlay

(in Rs.) (in Kg.)

10 100 1000
I 20 75 1500
40 65 2600 e <1

10 100 1000
II 20 50 1000
40 25 1000 e =1

10 100 1000
III 20 45 900
40 15 600 e >1
When price change from 10 to Rs.20 in the Ist case
Q1 = 100 Q2 = 75
P1 = 10 P2 =20
ΔQ = (Q2 – Q1) = 75-100 = 25
ΔP = (P2 – P1) = 20 – 10 = 10
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (25/100) X (10/10)
= 0.25
When price change from 20 to Rs.40 in the Ist case
Q1 = 75 Q2 = 65
P1 = 20 P2 =40
ΔQ = (Q2 – Q1) = 65-75 = 10
ΔP = (P2 – P1) = 40 – 20 = 20
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (10/75) X (20/20)
= 0.13
When price change from 10 to Rs.20 in the IInd case
Q1 = 100 Q2 = 50
P1 = 10 P2 =20
ΔQ = (Q2 – Q1) = 50-100 = 50
ΔP = (P2 – P1) = 20 – 10 = 10
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (50/100) X (10/10)
= 0.5
When price change from 20 to Rs.40 in the IInd case
 Q1 = 50 Q2 = 25
P1 = 20 P2 =40
ΔQ = (Q2 – Q1) = 25-50 = 25
ΔP = (P2 – P1) = 40 – 20 = 20
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (25/50) X (20/20)
= 0.5
When price change from 10 to Rs.20 in the IIIrd case
Q1 = 100 Q2 = 45
P1 = 10 P2 =20
ΔQ = (Q2 – Q1) = 45-100 = 55
ΔP = (P2 – P1) = 20-10 = 10
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (55/100) X (10/10)
= 0.55
When price change from 20 to Rs.40 in the IIIrd case
Q1 = 45 Q2 = 15
P1 = 20 P2 =40
ΔQ = (Q2 – Q1) = 15-45 = 30
ΔP = (P2 – P1) = 40 – 20 = 20
ep = ΔQ/ Q
ΔP/ P
ep = (ΔQ/ Q) X (P/ΔP)
= (30/45) X (20/20)
= 0.66
Point Elasticity Method

Point elasticity measures price elasticity at various points on the demand curve. When a point is
plotted on the demand curve, it divides the curve into two segments. The point elasticity is
measured by the ratio of the lower segment of the curve below the given point to the upper
segment of the curve above the point.
Point elasticity = lower segment of the demand curve below the given point
Upper segment of the demand curve above the given point
e = L
U
Where e stands for elasticity, L stands for lower segment, and U stands for upper segment.

At point c, price elasticity ep = CB/AC = 1; note that the line segment CB and AC are of equal
length.
At point A, ep = AB / 0; ep = §.
At point B, ep = 0 / AB; ep = 0.
At point D, ep = db / ad; ep > 1 because db>ad. Note that the length of line segment DB is
more than AD.
At point E, ep = EB / AE; ep < 1 because eb<ae. Note that the length of line segment EB is
less than AE.

Arc Elasticity of Demand

Arc method is used to measure the elasticity of demand for big change in price. The formula for
measuring price elasticity f demand through arc method is
ep= Original quantity- quantity after change/ Original quantity + quantity after
change
----------------------------------------------------------------------------------------------
Original price – price after change/ Original price + price after change
ep= ( Q - Q1)/ (Q + Q1)
(P - P1) / ( P +P1)
Illustration
Measure arc elasticity of demand for the following data.
Original price of a commodity = Rs. 10/-
Quantity purchased at this price = 100 units
Price after change = Rs. 5/-
Quantity purchased at new price = 300 units
ep= ( Q - Q1)/ (Q + Q1)
(P - P1) / ( P +P1)
( 100 -3001)/ (100 + 300)
(10- 5) / (10 +5)
(- 200/400)
(5/15)
(- 200/400) X (15/5)
= - 1.5
Arc method is the most popular method of measuring elasticity of demand.

Factors Determining Price Elasticity of Demand

The price elasticity of demand depends on several factors. They are as follows:-

1. The Nature of Commodity: Demand for necessary goods do not change with changes in their
price, and therefore their demand is inelastic. e.g., demand for salt or medicine. On the other
hand, demand for luxury goods is elastic. When their prices increase, consumers would postpone
their purchase and when their price falls, consumers are induced to purchase them e.g., demand
for air conditioners, electric chimneys etc.
2. Substitutes: Demand for those goods, which have several substitutes, is usually elastic;
because a slight reduction in the price of substitute goods leads to substitution effect and attracts
consumers to goods whose price has fallen. On the other hand, a slight increase in its price drives
away consumers to purchase other substitutes e.g., demand for toilet soaps.

3. Extent of Use: Demand for commodities, which have a variety of use is elastic. When their
price rises, their consumption will be restricted to most important use. Commodities, which have
limited use, are of inelastic demand.

4.Proportion of Income Spent: If the proportion of income spent on a particular commodity is

very small, its demand will be inelastic e.g., demand for salt, matches etc.

5.Possibility of postponement of use: If consumers can postpone the use of a commodity, its
demand will be elastic. Urgent wants create inelastic demand.

6. Durability of Goods: Durable goods are elastic because consumers replace them when their
price falls and postpone their purchase when price increase e.g., a consumer thinks of replacing a
car when its price falls.

7. Ranges of Prices: At very high level of prices and low ranges of prices, demand is inelastic.